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US exceptionalism: is era of strong returns over? · On The Money

• 0:03
  Kyle Caldwell: Hello, and welcome to the latest on the money podcast episode, a weekly look at how to make the most out of your savings and investments. So today's episode is focusing on whether investors have become too reliant on the strong returns of The US stock market. And joining me to discuss this topic is for manager Richard Saldanha, who manages the Aviva Investors Global Equity Income Fund. So, Richard, we're gonna be talking about lots of different topics associated with The US stock market today, including whether The US stock market is overvalued, concentration risk, political risk, and then we're gonna focus on the areas that you're investing in where you're seeing better value opportunities outside of The US. But let's start off with the term US exceptionalism.
• 0:59
  So in financial circles, US exceptionalism is being coined to describe just how exceptional The US stock market has been for investors over the past fifteen years. However, for around the past year or so, there's been more and more for managers and commentators questioning whether the exceptional returns of The US stock market can continue. What are your thoughts on US exceptionalism?
• 1:32
  Richard Saldanha: Yeah. It's a it's a good question, Kyle. And, look, I I think in some ways, talking about US exceptionalism, think slightly, you know, misses the point actually that from our perspective, The US very much still remains an exceptional place to invest. Right? And you think about the companies there, particularly, you think about the levels of cash generation, you know, capital allocation.
• 1:50
  You think about the returns on capital these companies generate, which typically for The US have actually been in excess of other regions historically. There's plenty of exceptional companies there. I think what is interesting from our perspective, particularly when you think about, you know, the composition of of global indices is The US is is is huge. Right? It's almost two thirds now of the global equity benchmark.
• 2:09
  So I think from that perspective, from an investor standpoint, it makes a lot of sense to think about, you know you know, other other regions and areas, and it's been interesting if you think about certainly equity market performance last year was a case in point where if you look at it in dollar terms, actually, you had significant outperformance from regions such as, you know, Europe and Asia and emerging markets. Right? So I think you'd I I think I'd almost say investors already thinking along those lines of going, yes. The US has been an exceptional place to invest. It's delivered phenomenal returns, but actually, it makes a lot of sense now to look at other regions as well.
• 2:40
  Kyle Caldwell: And due to the phenomenal returns over the past decades, fifteen years, the percentage weighting of The US stock market in global stock market terms has gone up a lot. You've mentioned that already around two thirds. If you look at the MSCI World Index, The US accounts for over 70%. So as global full manager, how do you how do you think about in in terms of context of, you know, you you you manage your funds, you have a certain remit, but ultimately, you wanna beat the alternative. You wanna beat a global index fund or a global ETF.
• 3:15
  So how how do you think about the the sheer size of The US stock market?
• 3:20
  Richard Saldanha: Yeah. So you're absolutely right. I mean, if you look at it, certainly the composition within the global benchmark, as I said earlier, it's, you know, two thirds of that index now is is one country alone. So, look, I think history is an interesting barometer. Right?
• 3:31
  When you think about, you know, you know, times in the past where you've had these levels of concentration, whether it be, you know, countries or even within, you know, stocks themselves, you tend to have a reversal of that. You know, something happens and actually that that changes over time. I think what is quite interesting is that, as I said, The US store remains an attractive place to invest. But certainly when you think about it from a valuation perspective and you look at kind of, you know, valuation metrics, whether it be sort of price to earnings, you know, cyclically adjusted price for earnings where you sort of take the PE ratio and you adjust it for where we are the cycle. I think what is quite interesting is that US market certainly looks a lot more stretched on that basis relative to other regions So I think that should also focus investors' minds when they come to thinking about that sort of diversification aspect, as I said.
• 4:10
  So, look, you know, if you look at the global equity income fund that we manage, you know, we've got about, you know, give or take 45% exposure to The US. So, look, it's still an attractive place to invest. We can find plenty of companies there that are paying, you know, attractive dividends, growing those dividends and those cash flows over time. But to us, it makes a lot more sense actually to be looking outside The US because the valuations, as I said, are are are certainly, you know, more attractive, I'd say. But, also, you can take part in in a lot of the dynamics that are driving US stocks, whether it be, you know, themes such as AI, energy efficiency, etcetera.
• 4:39
  So to us, that, you know, makes a lot of sense why you would look outside The US as well.
• 4:43
  Kyle Caldwell: And in terms of valuations, is The US stock market pricey on whole as an as an aggregate, or is it the sort of top end of the market, the so called magnificent seven stocks, the such a big part of The US stock market, are they the ones that are the most expensive and then that's pushing up the the the whole average?
• 5:04
  Richard Saldanha: Yes. So I I think one of the things you definitely are seeing this year is is it what we'd would call a broadening out effect. Right? So if you think about what what's been driving a lot of the returns that we've been talking about, there's exceptional returns in The US market, it has come from quite a concentrated cohort. And, you know, as you said, those magnificent seven companies, and, again, we understand what's been driving that, right, around the sort of themes of AI.
• 5:24
  But what is also quite interesting is you're definitely starting to see that broadening out taking effect. I mean, think about 2024 as an example, a lot of those US market returns were dominated by those magnificent seven companies. Now last year, only actually it might surprise you to know only two out of the magnificent seven stocks actually outperformed the broader index. So that's telling you in many ways that, you know, the equity investors are actually looking outside of those stocks. Because to your point, valuations do matter, and I think it is quite interesting you're starting to see that whether be even elements within the small cap, you know you know, area you've seen the Russell two thousand this year has actually outperformed the S and P index.
• 5:57
  Now we've had full stones in the past year around kind of small caps outperforming large caps, etcetera. But I think that's also quite interesting that actually investors are starting to look outside that very concentrated cohort of names.
• 6:08
  Kyle Caldwell: You've already mentioned that you're underweight The US stock market. I think you also underweight the magnificent seven stocks. Could you talk through your current positions?
• 6:18
  Richard Saldanha: Yeah. So, look, in terms of the magnificent seven companies, if you look at the portfolio right now, so we we own three out of those seven names. So Microsoft, which we've actually owned for well over a decade. And, again, from an income standpoint, what's usually on Microsoft, it it's been a very consistent dividend payer. I mean, it's actually it's not far off being what we would call a dividend aristocrat.
• 6:35
  So dividend aristocrat is a stock that has increased its dividend every single year for the past twenty five years, and Microsoft is actually very close to that. It's it's done that for almost twenty year well, know, over twenty years now. So, you know, we've we've owned that for a long time, well before the sort of, you know, theme around kinda AI really kind of took hold there. Alphabet, we we also own in the portfolio, and that's an interesting one, but they only recently initiated a dividend last year. So, actually, you had the dividends from first dividends coming from Alphabet and Meta last year.
• 7:01
  So I think it's quite interesting what you've been seeing in terms of the tech landscape and more and more companies paying dividends now, which actually means from an income standpoint, there's a lot more opportunity there. So, yeah, we took that opportunity, started a position in Alphabet last year, which is obviously, you know, know, worked worked for, you know, worked worked pretty well. And then we do own a small position in Nvidia as well, which does pay a dividend as well. But if you look in aggregate across our exposure, it's around 10% of the portfolio. Again, if you compare that to a sort of global benchmark where those magnificent seven stocks are almost a quarter, 25% of the benchmark, you can see we're relatively we own relatively less certainly compared to the global benchmark.
• 7:38
  Kyle Caldwell: And going back to valuations, of course, history shows valuations are very key for long term returns. So given the price earnings ratio on The US market, I think it's around 30 times at the moment. Does that inform investors that over the next ten years, returns are gonna potentially be lower than they have been over the previous ten years?
• 8:02
  Richard Saldanha: Yes. So, again, history is a kind of interesting guide here because, again, taking the point around PE ratios, whenever you see you know, if you look at that sort of cyclically adjusted, that sort of cape PE that we talked about earlier. Now, typically, when you get to levels that are quite elevated, that tends to mean the sort of future returns tend to be lower. And, certainly, look, we're coming off the back of a period where you've had, certainly post 2022, you know, three years of exceptional returns. I mean, even global stock markets are up sort of 20% in US dollar terms every year for the past three years now, which is, you know, quite exceptional in that sense.
• 8:31
  So, look, I I think when we think about, you know, it from an investor standpoint, you know, are we gonna be able to to sustain those levels of returns? Quite unlikely, I'd suggest. Now that doesn't mean equity markets can't continue to remain buoyant. There's lots of themes that I think are driving markets over the long run that broadening out, I think, will help somewhat when you think about, you know, other parts of the market that perhaps haven't necessarily kind of, you know, been participated as much in that in that strong performance. But I think the reality is investors should be mindful of, you know, the potential for lower returns and even drawdowns in markets.
• 9:03
  Let's not forget. Right? So I think that should also focus investors' minds when they think about constructing portfolios as well, is to be mindful of some element of downside protection as well, I'd suggest.
• 9:12
  Kyle Caldwell: Wanted to next ask you about political risk. Of course, last year, from around mid February to around mid April, US stock markets and global stock markets suffered quite heavy falls in response to it becoming sort of clearer The US tariff policy, what what that would be. And, of course, from around mid April onwards when there was that ninety day pause in US tariffs, that settled markets down. And then since then, we've seen a very strong recovery play out. Now, of course, I think a lot of investors were hoping The US tariffs would be in the rear view mirror this year, but then we have the proposed threats of tariffs being introduced on several European nations in response to US president Donald Trump's plans to try and take over Greenland.
• 10:07
  What are your thoughts on how political risk could sort of spell the end of US exceptionalism?
• 10:15
  Richard Saldanha: Yeah. So look, to your point on sort of geopolitics, I think that's something that, you know, has been in the background quite a while. It's it's intensified, if anything, to your point this year when you think about what's happened, particularly, you know, aspects around the events in Venezuela, Greenland that you highlighted as well there. Look. From an investor standpoint, I think the reality is you have to deal with that somewhat.
• 10:34
  I mean, we put out a sort of thought piece last year sort of saying, look. The amount of headlines and political noise that you're seeing, I'd argue, certainly in my twenty years as a fund manager, I've never seen it at such a such a high level. So, look, I I think the reality is as as fund managers, our job, you know, we're very much bottom up focused when we think about what we're, you know, looking at whether it be the kind of drivers on the industry level or even from a company level. Again, it's, you know, focusing on the fundamentals, the earnings, the cash flows, and obviously the valuation context there. But the reality is, look, the geopolitics politics certainly has an impact.
• 11:03
  You know, we've seen that in terms of the sort of volatility in the market at the same time. But I think companies have shown they're actually pretty resilient in many ways to a lot of these sort of geopolitical events that are happening right now. Look. In terms of that sort of the the the political side of things, I think sometimes it can throw up some opportunities, which is quite interesting to us. And I think last year was a sort of case in point, and, you know, just to take an example, the health care sector as as an example.
• 11:26
  Right? There's a lot of kind of political noise whether we obviously around tariffs, elements around drug pricing, health care reform, etcetera. And, actually, you saw that impact the sector massively, right, when you think about the derating that you saw in the health care sector. Now, again, as investors looking at the bottom up fundamentals and actually taking a slightly longer term view, we felt that it was almost peak fear. Like, a lot of, you know you know, downside was sort of, you know, in the share prices that were priced in.
• 11:50
  And, actually, that's when you can, you know, take a more constructive view as a, you know, from an investment standpoint and and and and take that longer term lens and step in. So the the I suppose the point I'm trying to make is the political noise does create opportunities, but you also have to have a bit of a thick skin and think about it over the long term because certainly over the short term, it does create a lot of volatility.
• 12:09
  Kyle Caldwell: So as you've already noted, so around 45% of the fund is in The US. You've got a global remit. So where's the rest of the funds invested?
• 12:19
  Richard Saldanha: Yeah. Good question. So, look, I I think when we think about the sort of regional allocation, and again, sort of thinking about it from an income standpoint, certainly, you know, you tend to find quite attractive dividend paying companies, particularly in Europe. Obviously, UK is part of that, but also in, you know, across Europe, there tends to be, you know, companies that are paying quite attractive dividends and and and and growing those dividends. Asia and Emerging Markets has certainly been a kind of fertile hunting ground in many ways when you think about it from a from an income standpoint.
• 12:43
  I think what's been quite interesting, I mean, obviously, The US has, you know, delivered really strong levels of of of cash flows, you know, and these companies have certainly from a capital allocation standpoint have done exceptionally well. But I think you're starting to see a lot of these, you know, elements, particularly outside of The US. Right? So I think you you know, particularly in Europe, but also in Asia, you're starting to see, you know, companies that are, you know, generating healthy levels of cash flow, growing those cash flows, and and and some pretty attractive sort of industry growth drivers as well. I think the context again with the valuations is certainly what, you know, what really, you know, attracts us there because it's certainly on a relative basis, you know, it it's more attractively valued.
• 13:19
  So I think, again, you know, you think about our exposures, you know, whether it be in Europe and and in Asia, and I think, you know, that's something that, you know, we can see persisting for quite a while, actually. Yeah.
• 13:29
  Kyle Caldwell: How much percentage exposure do you have to Asia? As I know that some global funds just invest in developed markets. So, I mean, this is certainly for me, you know, whenever I see any global fund have exposure to Asia or emerging markets, I actually think that's more unusual these days rather than it not being.
• 13:46
  Richard Saldanha: Yeah. Yeah. You're right in some ways. But I I guess the way we think about it, again, we try and understand the business models. And, actually, these are big global companies in many ways, Wadd, when you think about it.
• 13:55
  So, you know, you obviously got the likes of TSMC in Taiwan. You think about some of the companies, you know, in in, you know, pockets of Asia. You know, AIA is a good example in the kind of insurance space. But the nice thing is I think there's some interesting demographical shifts, though. So, I mean, to take AIA as an example, actually, when you think about the sort of, you know, protection gap that exists right now, whether it be in kinda health insurance, life insurance, etcetera, you've got companies that are addressing that.
• 14:17
  Even in the con kinda consumer staples landscape is quite interesting because you've got companies that actually aren't listed in Asia, but are listed in, you know, you know, areas such as Europe and The US. You think about companies such as Unilever being a good example that are benefiting from some of the trends that you're seeing in emerging markets, whether it be the sort of strength of the end consumer, etcetera. Right? So you you can definitely play into some quite interesting demographic shifts that are taking place there right now. And as I said, I think that, you know, you've you've got companies actually with with pretty good track records when it comes to paying dividends and growing that income stream over time.
• 14:46
  So for us, that tends to be kind of what piques our interest when we can see companies that have kind of done that over cycles, you know, consistently, you know, growing that that income over time. And I think Asia certainly offers that right now to investors.
• 14:58
  Kyle Caldwell: And do you have exposure to our own home market, The UK?
• 15:01
  Richard Saldanha: Yeah. We do. I mean, again, it it tends to be with companies that have quite a sort of global footprint, again, when we think about it. But, you know, certainly when we look at our, you know, exposure from a from a UK context, you know, we've got companies such as, you know, highlighted, obviously, Unilever as an example, but also across, you know, other parts of, you know, the the sort of complex as well. So we've got companies such as Experian in the kind of, you know, in the sort of in the sort of credit bureau space as well, which is a quite interesting kind of company there that's, again, you know, you know, very well in terms of its, you know, from, you know, from a cash flow standpoint.
• 15:34
  So, look, I think The UK still remains an attractive place to invest. I think it's it's interesting in The UK side. Certainly from a capital allocation standpoint, you're seeing companies, you know, deploy some of that capital, whether it be buying back their own shares. And if you got the level of share buyback in The UK market, it's kind of increased quite materially over the last few years there. So I think that it's an interesting kind of case study again where global companies that are, you know, benefiting from a lot of the trends that US companies are benefiting from.
• 15:57
  But, again, the valuations, I think, are certainly, you know, not as extreme. You've mentioned cash flow a couple of times. So when you're scanning the global universe for income opportunities,
• 16:09
  Kyle Caldwell: is there a certain level of dividend growth that you're looking forward? Is there a certain dividend yields? Is there is there, like, a a low threshold that a company has to meet?
• 16:17
  Richard Saldanha: Yeah. So, look, for us to to to come into the portfolio, the company just has to pay a dividend. Right? So that that's the sort of starting requirement. We don't invest in companies that don't pay a dividend.
• 16:26
  But, again, as we think about where we source that income from, it's actually pretty diverse. So we tend to think about it in terms of what we call income buckets. Right? So we have three buckets of income where we source from. So the first one is what we call mature yielding companies.
• 16:38
  So these are companies that tend to pay quite high yields. So often, you know, the headline dividend yield would be, you know, 4% even higher than that. Now that tends to focus on certain sectors, right, when you think about it. So that tends to be, you know, sectors such as pharma would be a good example. You think about telecoms, utilities, some of the sort of staples companies as well, which sort of fit within that bracket, some financials too.
• 16:58
  Then we have what we call our core yields. So these tend to be companies that can compound that income stream over time. They're very consistent, almost steady Eddie types of business models. You're getting a nice compounding of the of the cash flow and income stream over time. Typically, those yields tend to be sort of around two two, sort of 3% there, but there's a very consistent level of income growth that you're getting.
• 17:17
  And then finally, we have what we call our income growth bucket. So these are companies that tend to operate in industries where you can see pretty attractive structural growth prospects. So technology would be a prime example of that. Some industrials are sort of playing into the sort of AI theme would also fit into that bucket as well. Now, typically, with the income growth bucket, those dividend yields are actually quite low.
• 17:34
  So sometimes, there might be point 5%, 1%, etcetera. But what we most really like about that bucket is the levels of income growth were actually pretty pretty high. Right? So typically, income, you know, growth types of businesses will be growing their income stream at, you know, well over double digits, so mid teens annualized growth or even higher. And that's thanks to the level of cash flow growth these companies are generating.
• 17:55
  So the key for me is from a portfolio construction, you know, standpoint, making sure we combine those buckets together because, actually, they offer you quite different qualities through the cycle. So you think about those mature yielding businesses, they tend to be quite defensive, offer you that downside protection, contrast that with the income growth types of companies that tend to do quite well in periods where the market is buoyant. So, actually, you know, being able to source income across a wide range of of yields and and industries is actually quite beneficial, we find.
• 18:23
  Kyle Caldwell: And when you're particularly with those companies that are have higher yields, how do you make a judgment call that a company is not over prioritizing a dividend as, you know, there's been various instances over over over time. When a company does tend to over prioritize, that can that can really impact the growth of company very negatively.
• 18:44
  Richard Saldanha: Yeah. Absolutely. And I think the sustainability of the dividend is something that we we are really focused on. Because to your point, you know, we've certainly seen, you know, periods in the past where, you know, what might look like a very high yield and an attractively high yield actually isn't sustained, and you get companies that cut their dividend, whether it be the sort of cyclical, you know, types of businesses or, you know, to your point that, you know, they're actually allocating too much into increase the dividend, not thinking about, you know, other parts of their their business model. So there's definitely a fine balance between, obviously, paying an income, which, you know, we like and we think is attractive, but also thinking about, you know, investing in your business, growing your business over time because, ultimately, that's what drives the dividend growth.
• 19:22
  It's the ability to grow those cash flow streams over time. So, again, that is something we're really, you know, almost laser focused on when it comes to thinking about investing in that. And we've certainly seen episodes in the past where, you know, COVID being a prime example. We had a lot of companies, you know, cutting their dividends. I mean, if you look to the portfolio, you know, I think only one of our companies actually actually suspended its dividend out of the 40 names that we held in the fund right then.
• 19:44
  So it is something we we absolutely do consider when it comes to investing. We want to be able to think ahead and think, are these companies gonna be able to sustain those if they are high yields going into the future.
• 19:54
  Kyle Caldwell: Richard, thank you very much for your time.
• 19:56
  Richard Saldanha: Pleasure.
• 19:57
  Kyle Caldwell: So that's it for our latest on the money podcast episodes. We love to hear from listeners, and you can get in touch by emailing otm@ii.co.uk. And in the meantime, you can find plenty of insights and practical pointers on the Interactive Investor website, ii.co.uk, and I'll see you next week.